When Is A QCD Not Really A QCD (Non-Taxable Distribution)? Watch Out If You Make Deductible IRA Contributions
A big change related to qualified charitable distributions (QCDs) has been highlighted in the Feb. 28 release of the official IRS Publication 590-B for the 2021 tax season. The QCD change affects those over age 70 1/2 who make deductible contributions to their IRAs.
Reminder: “A QCD is generally a nontaxable distribution made directly by the trustee of your IRA (other than a SEP or SIMPLE IRA) to an organization eligible to receive tax-deductible contributions. You must be at least age 70 1/2 when the distribution was made,” according to Pub. 590-B.
SECURE Act Changes
The draft version of Pub. 590-B, released in January, noted that “Qualified charitable distributions (QCDs) may be reduced. Beginning tax years after December 31, 2019, your maximum annual exclusion for QCD may require an additional adjustment.”
This stemmed from the Setting Every Community Up for Retirement Enhancement (SECURE) Act, signed into law at the end of 2019. The law provided that taxpayers who make a deductible IRA contribution after turning age 70 ½ (the age you can start making QCDs) must adjust the QCD downward to account for the contribution.
QCD Adjustments Clarified
In the new Pub. 590-B version, there is not only a significant revision to the worksheet, but there also are more details on how to calculate the effect of deductible IRA contributions on QCDs. The section titled “Offset of QCDs by amounts contributed after age 70 ½” (Page 15) uses “Jim” as an example of how to handle the QCD Adjustment Worksheet over a two-year period.
In the example, Jim, who turned 70 ½ in 2019, made deductible IRA contributions of $5,000 each for 2020 and 2021 but no contribution for 2022. He made a QCD of $6,000 for 2021 and $6,500 for 2022 (but no QCD for 2020).
But, because Jim made deductible IRA contributions, these intended QCDs may not get QCD treatment, meaning they may not be excludable from income.
QCD Excludable? Maybe. Maybe Not.
What does “excludable” mean? The QCD amount is excludable from gross income on a tax return, provided the taxpayer meets the requirements. And now, the QCD must also pass another test if you made deductible contributions to your IRA.
Jim fulfilled his qualified charity and direct transfer requirements. But, what about his deductible contributions? Will they prevent his QCD from being excludable from his income? That will depend on the results of his Adjustment Worksheet.
How To Calculate The Adjustment
Jim turns to the QCD Adjustment Worksheet for tax year 2021.
Line 1 asks for the “total amounts of [IRA] contributions deducted in prior years that you were age 70 ½ or older that did not reduce the excludable amount of qualified charitable contributions in prior years.”
Since Jim is using this worksheet for the first time, he enters 0, because he is not carrying over deductible IRA contributions from a previous year’s worksheet. (That situation changes for Jim on his 2022 worksheet.)
Line 2 asks for the total IRA amounts contributed and deducted during the current year if you were age 70 ½ (or older) at the end of the year. The form cautions that if it is your first QCD worksheet (as in Jim’s case), you must include the contributions you deducted in prior years in which you were age 70 ½ or older at the end of the year. For Jim, this means entering $10,000 for the combined total of 2020 ($5,000) and 2021 ($5,000).
Line 3 says to add the amounts of lines 1 and 2. For Jim, that is $10,000.
Line 4 calls for the QCD Jim made for the current tax year (2021), which was $6,000.
Line 5 says to subtract line 3 from line 4 to get the amount of excludable QCD for the current year. In Jim’s case, it comes out to a negative $4,000. Now what?
When Is A QCD Not A Non-Taxable Distribution?
The Adjustment Worksheet will tell you if your intended QCD is indeed excludable from income.
There is an asterisk for line 5: “If zero or less you have no excludable qualified charitable distribution. If zero or greater enter -0- on line 1 of your subsequent QCD worksheet. If less than zero enter the amount as a positive amount on line 1 of your subsequent QCD worksheet.”
Jim has no excludable QCD for tax year 2021. His QCD ($6,000) must be included in his gross income as a distribution from his IRA.
To address Jim’s negative $4,000 for 2021 and its carryover to 2022, let’s look at the second example provided by Pub. 590-B.
The Following Tax Year
The example for Jim’s 2022 tax year starts with him using the QCD worksheet and entering a positive $4,000 on line 1 (remember, “total amounts of contributions deducted in prior years that you were age 70 ½ or older that did not reduce the excludable amount of QCD in prior years”). In other words, this was the amount that did not impact the QCD made by Jim in 2021.
Jim did not make any deductible IRA contributions for 2022, so line 2 is 0, and adding lines 1 and 2 gives him a $4,000 total for line 3.
For line 4, his QCD in 2022 is $6,500. On line 5, after subtracting line 3 ($4,000) from line 4 ($6,500), Jim sees that the amount of his excludable QCD for the 2022 tax year is $2,500, so he can exclude that amount from his gross income. Also, since $2,500 is greater than 0, per the asterisk for line 5, Jim will enter 0 on line 1 of his 2023 tax year QCD worksheet. There will be no impact on a 2023 QCD for the deductible IRA contributions Jim made in previous years.
Check With Your Adviser
As always, be sure to check with your tax adviser before taking any actions based on general information. Each individual’s situation is unique; only your tax adviser can help you decide what actions to take or not take respecting IRAs and QCDs. You might also want to discuss any plans going forward for QCDs and deductible IRA contributions.
To keep up with topics that I cover, be sure to follow me on the forbes.com site (and if you would like to subscribe, check out the red box at the top right). Write to me at firstname.lastname@example.org. Include your city and state, and mention that you are a forbes.com reader. While all questions cannot be answered, each email is read and reviewed and can lead to discussion in a future post.